JULY 2011 Rakesh Kumar DEPARTMENT OF ECONOMIC AND POLICY RESEARCH W P S (DEPR) : 9 / 2011 RBI WORKING PAPER SERIES

Treatment of Valuables as Capital Formation in India: Some Issues and Perspectives Copyright: Reserve Bank of India 2011 The Reserve Bank of India (RBI) introduced the RBI Working Papers series in March 2011. These papers present research in progress of the staff members of RBI and are disseminated to elicit comments and further debate. The views expressed in these papers are those of authors and not that of RBI. Comments and observations may please be forwarded to authors. Citation and use of such papers should take into account its provisional character. TREATMENT OF VALUABLES AS CAPITAL FORMATION IN INDIA: SOME ISSUES AND PERSPECTIVES Rakesh Kumar Abstract As per UNSNA recommendations, valuables as a separate item had been introduced i n the expenditure side of GDP. Since India is one of largest importer and user of gold for various purposes, this treatment resulted into higher share of valuables in capital formation in t he economy. Moreover, from conceptual aspect, these valuables are not related to capital formation in the economy and are kept as a store of value, thus, the paper argues against this recommendation of UNSNA (1993and 2008) for the Indian case. Secondly, from the compilation aspect, it may be stat ed that the base revision in 1999-2000 had resulted into drop in the quantum of errors and omissio ns and statistical discrepancies in the national account statistics. Thus, there is need to improve the estimates of valuables on the basis of sound methodology. As per the latest round of Internal Co mparison Practice (ICP) by World Bank (2005), the world average of change in stock and valuab les together constitutes roughly 2 per cent of GDP, while it is significantly higher in India than the global average, partly on account of huge preference for holding gold jewellery by hous eholds in India. This study addresses some of these issues pertaining to the treatment of valuables in t he national accounts statistics. Furthermore, the study discusses the rationale of classific ation of valuables in the UNSNA (1993 and 2008) and points out the implications for the Indian economy whi ch is one of the largest consumers of gold in the world. JEL Classification: E21, E22 Keywords: Saving, Investment Introduction The expenditure side of gross domestic product (GDP) measures the use of goods a nd services produced in the economy. It provides the details of consumption, invest ment, exports and imports of goods and services. This study argues against the present classif ication of valuables in the gross capital formation from the perspective of United Nationa

System of National Accounts (UNSNA) 1993 and 2008 which states that they are held for stor e of value without any use for production and consumption in the economy. India is one of t he largest importers and user of gold items for jewellery and other uses. Thus the present treatment of valuables has resulted into significant rise in capital formation activity. It m ay be highlighted The preliminary version of this study was presented in the Annual Conference of the Indian Association of National Income and Wealth, Trivandrum. Author (rarya@rbi.org.in) is Research Officer in the National Accounts Analysis Division of the Department of Economic and Policy Research (DEPR) of the Reserve Bank of India, Mumbai. The views expressed in this paper are personal views and do not reflect the views of the RBI. The comments a nd suggestions received from Smt. Balbir Kaur, Adviser DEPR, are gratefully acknowledged. 1 that the Indian economy could be cited as a unique case where the recommendation of UNSNA for estimation of valuables and its treatment in capital account of the na tion have somewhat inflated the estimates of gross capital formation to the extent of 1.3 per cent of GDP. Moreover, over the period, the debate on the issue of treatment of non-monetary gold and its inclusion in the capital account unlike monetary gold, which is placed in th e balance sheet of monetary authority has emanated among the countries like the UK and Japan. Th us, the study addresses some of technical details of the concept of non-monetary gold an d its impact on measurement of valuables in India. The study is set out in four sections. Section II provides the conceptual issues and treatment of valuables in the UNSNA framework. Section III covers select country practices. Section IV provides details of gold demand and valuables in India and Section V discusses some measurement issues. Finally, Section VI provides the possible policy sugges tions and summing up. Section II Concept of Valuables and its treatment in UNSNA India being one of the member countries of UNSNA has adopted the recommendations of the UNSNA 1993 and placed estimates of valuables in the expendi ture side of GDP as a separate category of expenditure. The valuables are broadly non-m onetary gold and other precious metals and piece of art and antiques appearing as a sepa rate category in gross capital formation (GCF) estimates. As per the UNSNA, 1993, the valuables are defined as follows: Precious stones and metals such as diamonds, non-monetary gold, platinum, silver , etc., held by any unit including enterprises provided that they are not intended

to be used as intermediate inputs into processes of production; Paintings, sculptures, etc., recognized as works of art and antiques; and Other valuables, such as jewellery fashioned out of precious stones and metals a nd collections. In terms of sequence of national income accounts, acquisitions and disposals of new or existing assets in the form of valuables are recorded in the capital account. T hey are valued at the actual or estimated prices payable by the units acquiring the asse ts to the units disposing of the assets plus any associated costs of ownership transfer incurred by the units acquiring the assets such as fees payable to expert valuers, agents and auctione ers. The prices of valuables payable to dealers include their margins. Disposals are valued at the prices payable by the units acquiring the assets to the units disp osing of the 2 assets minus any associated costs of ownership transfer incurred by the latter. On aggregation, therefore, acquisitions less disposals of valuables include dealers ' margins and the costs of ownership transfer on new and existing valuables, whether the trans actions consist of purchases and sales, barter or capital transfers in kind. Shift in treatment of valuables from earlier practice The 1993 UNSNA recommends inclusion of expenditures on valuables in the capital formation estimates (UNSNA93 Annex I paragraph 78). From the viewpoint of data u sers, the idea of including valuables in capital formation may not be readily apprehen sible (OECD/ESCAP: Meeting On National Accounts: 1998). In the earlier version of UNSNA (1968) valuables were treated in various ways fo r instance precious metals acquired by households were included in household final consumption expenditure. Moreover importantly, other institutional units/sectors were allowed to hold gold and other precious metals like gold. In the revised UNSNA 1 993, gold was classified as (1) monetary gold, (2) gold held as store of value and (3) gol d used for industrial purposes. A transaction in the first category was categorised as fina ncial transaction, while the transaction of gold in the last two categories was classi fied as transaction in commodities. The rationale for monetary gold transaction as finan cial transaction is mainly built on the premise that this kind of transaction is allo wed only between central banks two countries. In the UNSNA sequence of accounts, the accumulation accounts consist of the capi tal account, which records transactions in nonfinancial assets and capital transfers ; the financial account, which records transactions in financial assets and liabilities; and the accounts for other economic flows, which record revaluations and other changes in the volume of assets.

In the capital account, the balancing item is net lending/borrowing (NL/B). If a n economy s saving and capital transfers exceed its net acquisition of nonfinancial assets, then it is a net lender to the rest of the world. Conversely, if its net acquisition of nonfinanc ial assets exceeds its saving and capital transfers, it is a net borrower from the rest of the world. The capital account records the transactions acquisitions/disposals of nonfinancial assets and capital transfers (Table 1). The right-hand side of the account comprises saving and net capital transfers (that is, changes in net worth owing to saving and capital transfers). The left-hand side shows transactions in nonfinancial assets . If, in the capital account, the aggregate of saving and capital transfers exceeds the net a cquisition of nonfinancial assets, the balancing item is net lending (+), which measures the s urplus an economy has lent to the rest of the world. On the other hand, if saving and capi tal transfers taken together are insufficient to finance the net acquisition of nonfinancial a ssets, the balancing item is net borrowing ( ), which corresponds to the deficit the economy has been obliged to finance by borrowing from the rest of the world. 3 The financial account shows how an economy undertakes the NL/B through transactions in financial assets and liabilities. The account is classified by f inancial instrument, with the net acquisition of financial assets shown on the left-hand side, and the net incurrence of liabilities on the right hand side. The non-monetary gold held in anticipation of appreciation in value is termed as valuables and recommended to be placed in the capital account of the nation. The conceptual logic for this treatment of non-monetary gold arises from the nature of transaction (commodity not financial) and long-term gain associated with it due to its store of value attribute. Despite the fact that this does not result into capital formation act ivity, it is placed in capital account of the economy. In other words, valuables are treated as assets and included in investment and net wealth, even though they are not used primarily f or the purposes of production or consumption (Table 1). Table 1: Capital and Financial Accounts of the Nation Capital account Changes in assets Changes in liabilities and net worth Saving Gross fixed capital formation Consumption of fixed capital (-) Changes in inventories Acquisitions less disposals of valuables Acquisitions less disposals of non-produced assets Capital transfers, receivable (+) Capital transfers payable (-) Net lending (+) / net borrowing ( ) Changes in net worth due to saving and capital transfers

Financial account Changes in assets Changes in liabilities and net worth Net lending (+) / net borrowing ( ) Net acquisition of financial assets Net acquisition of financial liabilities Monetary gold and SDRs Monetary gold and SDRs Currency and deposits Currency and deposits Debt securities Debt securities Loans Loans Equity and investment fund shares Equity and investment fund shares Insurance, pension and standardized guarantee schemes Insurance, pension and standardized guarantee schemes Financial derivatives and employee stock options Financial derivatives and employee stock options Other accounts receivable/payable Other accounts receivable/payable 4 Gold as a financial asset Assets are owned by institutional units, from which economic benefits may be der ived by their owners by holding them or using them for a period of time. In this rega rd, 'future economic benefits' usually mean that the asset will contribute in some way to th e provision of services or other outputs. Assets can be financial (bank deposits, bonds, loans, shares, accounts receivables) or nonfinancial (land, buildings, vehicles, equipment, mac hines, right to use physical structures or information, goodwill and other intangibles, stock s and valuables). The most profound reason of treatment of non-monetary gold as non-financial asse t looks weak. However, strong arguments can be given in favour of gold as a financ ial asset. Historically, gold has been used as a medium of exchange or directly as near mon ey. Even today, during financial or currency crises, it is used for settlement of debt ob ligations. While describing the attributes of gold, once Columbus stated Gold is a wonderful thing ! Whoever possesses it is lord of all he wants. By means of gold one can even get souls in to Paradise. Gold has a number of characteristics that can make it more like a financial asse t than a commodity or valuable such as fine art, antiques or even other precious metals: It is traded round the clock on financial markets in a way similar to foreign currencies. At any time there is a quote and recognised international price base d on standard definitions. Gold is readily assayed and any form of gold can be re-processed into standard high quality bars for sale in the market. The gold markets are highly liquid. Average turnover in London, New York and Tokyo combined is in the region of 50 million troy oz per day (worth around $20bn). Gold is traded not just in the spot market. There is a highly sophisticated mark et in secondary and derivative instruments just as would be expected for a financial

asset. There is gold lending/deposit market and quoted interest rates. Gold traded as a commodity and bought for end or intermediate use in the product ion process, for industrial inventories or as a store of wealth. Therefore, treatmen t of nonmonetary gold as non-financial assets may not hold sound due to very basic nature and intrinsic value associated with gold. Section III Select Country Practices - UK, Euro Stat and the US In line with the UNSNA 1993 recommendations, most of the member countries have accepted the concept of valuables and its inclusion in the gross capital formation (GCF). If 5 we look at the World Bank s latest round of International Comparison Practice (ICP : 2005), very few countries out of 146 report valuables as a separate category in the estim ates of gross capital formation. Most interestingly, the change in stock (inventories) a nd net acquisition of valuables together accounts for only 2 per cent of GDP of the wor ld as a whole. As against it, in India, these two components constituted, on an average, 4 per cent of GDP in the last four years, of which, the valuables constituted roughly 1.3-1.4 per cent of GDP at market prices which is almost equal to the current account deficit of a country in the normal years. Classification of gross capital formation Internationally all the national accounts offices follow same definition of gros s capital formation where the net acquisition of valuables is shown as a separate category . In the UK national accounts, valuables are non-financial goods that are not used primarily for consumption. These precious metals do not normally deteriorate over time and are acquired and held primarily as stores of value. In internationally-accepted economic acco unting practice, acquisitions and disposals of valuables by different entities are divi ded into: Financial intermediaries (including central banks) dealing in non-monetary precious metals; Enterprises which do not trade in these products (and for whom they therefore do not count as intermediate consumption or fixed capital formation); Households (for whom they do not count as final consumption expenditure). The European System of National Accounts goes a step further by providing the details in respect of the following: Jewellers and art dealers (though in principle their transactions in such items should count as changes in inventories); Museums (though in principle their transactions should count as fixed capital formation). These additional conventions avoid the need for frequent reclassification betwee n the three types of capital formation as goods change hands within the art and antiqu ities market. Production of valuables is valued at basic prices and all other acquisitions at pu rchasers prices (including agents fees or commissions and dealers margins). Disposals are v

alued at the prices received by sellers less fees and commissions. Monetary versus non-monetary gold Gold held by the monetary authorities (usually Central Banks) as part of the off icial reserves of a country or by international financial institutions such as the IMF and BIS is classified as monetary gold and a financial asset. 6 Table 2: Proportion of Gold in official reserves (June 2010) Description Reserves (US$bn) Gold (tonnes) Gold as % 1 2 3 4 1 US 424 8,134 72% 2 Euro area 698 10,793 58% 3 Switzerland 260 1,040 15% 4 UK 75 310 16% 5 India 284 558 7% 6 Russia 475 726 6% 7 Saudi Arabia 444 323 3% 8 China 2,577 1,054 2% 9 Japan 1,076 765 3% Source: World Gold Council, IMF (World official gold holdings as at the end of J une 2010, September 2010 Report) Monetary gold is a financial asset by convention, because monetary authorities m ay use it in settling financial claims. Monetary gold is a financial asset not havi ng a corresponding liability. The select countries holding of gold as reserve assets i s placed in Table 2. The non-monetary gold is, however, treated as a commodity either for intermediat e consumption or additions to inventories (for industrial use e.g. for electronics , dental or jewellery manufacture) or as a store of wealth classified in the capital account a s valuables alongside precious stones and works of art etc. This practice has been followed in the UNSNA 1993 which had disbanded the earlier classification of financial gold. In the present set up, the entire gold holding is divided into monetary gold, which is placed i n the balance sheet of a central bank while the non-monetary gold (after adjusting for the ind ustrial use) is included in the estimate of valuables . This treatment of valuables has a critical significance for the countries like UK, Japan and India with large imports of bu llion. Under the UNSNA 1968, gold was classified into two categories: financial (includ ing monetary) and industrial (or commodity) gold and all sectors of the economy were permitted to hold gold as a financial asset. However, the Balance of Payment Manual-4 (BPM 4), in contrast, permitted only the monetary authorities to hold gold as a financial as set, as in the current standards of UNSNA 1993. The SNA expert group on external transactions a greed on the current treatment but with minority objections from the UK and Japan. In the IMF

committee of expert group, it was found that only the US appears to have fully f ollowed the current international standards for non-monetary gold. Switzerland, and to a les ser extent Japan, has retained a wider interpretation of gold as a financial asset, while t he UK has been unable to implement the treatment of non-monetary gold due to lack of data on cr oss border changes of ownership of gold (Philip Turnbull: 2004). 7 Section IV Gold Demand and Valuables in India Over the period, the valuables have started to account for a significant portion in the gross capital formation in India. During 2008-09, the valuables as per cent to G DP increased to 1.4 per cent which is the highest level so far since 1999-2000, the year from which the practice of dissemination of estimates of valuables as a separate category started in India (Table 3). According to CSO s Sources and Methods 2007, the valuables are assets tha t are not used primarily for production or consumption, do not deteriorate over time u nder normal conditions and that are acquired and held primarily as stores of value, these ar e namely, gold, gems, ornaments and precious stones. Monetary gold is, however, not part of the valuables. The valuables also have industrial use. The norms of 95 per cent and 10 per cent, respectively for gold and silver, have been used, to arrive at the estimates on acquisition of these items as a store of value. Table 3: Expenditure Side of GDP Item (Amount in Rs. crore) Percentage to GDP at market Prices 2007-08 2008-09* 2009-10# 2008-09 2009-10 Private Final Consumption Expenditure 2,485,554 2,655,533 2,769,769 59.5 57.6 Government Final Consumption Expenditure 438,976 512,126 565,860 11.5 11.8 Gross Fixed Capital Formation 1,414,975 1,471,161 1,576,445 32.9 32.8 Change in Stocks 154,033 59,812 63,327 1.3 1.3 Valuables 47,456 58,673 63,503 1.3 1.3 Exports 917,455 1,094,929 1,022,029 24.5 21.3 Less Imports 1,113,113 1,369,202 1,269,570 30.7 26.4 Discrepancies -97,417 -17,672 15,860 -0.4 0.3 GDP at market prices 4,247,918 4,465,360 4,807,222 100 100 *: Quick Estimates; #: Revised Estimates Source: Central Statistics Office, GOI The reason for such a high share of valuables in GDP emanates from the huge demand of gold in India. India has the world s largest gold consumer market. In 20 09, total Indian gold demand reached US$19bn, accounting for 15 per cent of the global gol d market. Since the last ten years, the value of gold demand in India has increased at an average rate of 13 per cent per year. In India, gold is perceived as a symbol of security and as a sign of prosperity. The lack of financial education and relatively less developed financ

ial system, purchases of gold jewellery are considered as a form of liquid and tradable inve stment for the accumulation of wealth. Gold jewellery accounted for around 75 per cent of total Indian gold demand in 2009, the remainder being investment (23 per cent) and decorative and industrial use demand (2 per cent) for gold. Indian consumers also regard gold jewellery as an 8 investment and are well aware of gold s benefit as a store of value (World Gold Co uncil, 2010). The valuables are held in expectation that their prices, relative to other goods a nd services, will not decline over time and possibly increase. In other words, valua bles are generally expected to hold their value in real terms in the long run. This practice followed in India is in accordance with the recommendations of 199 3 UNSNA. The data on expenditures made on net acquisition of valuables on precious i tems like gold, gems, ornaments and precious stones etc, has been included under gros s capital formation, as a separate category under produced fixed assets (separately from the gross fixed capital formation (GFCF) and change in stocks). Table 4: Gross Domestic Products Expenditure Side ( as per cent of GDP) (Base 1993-94) Item 1999-2000 2000-01 2001-02 2002-03 2003-04 Private final consumption exp. 65.5 64.8 65.4 64.3 63.8 Government final consumption exp 13 12.6 12.5 11.8 11.3 Net Exports -2.0 -0.9 -0.9 -1.0 -1.3 Gross domestic capital formation 25.3 23.8 22.6 24.8 26.3 Errors and Omissions 1.7 1.2 0.4 2.1 3.3 Statistical Discrepancy -0.1 0.9 0.8 2.2 3.1 Gross Domestic Product market prices 100 100 100 100 100 Gross Domestic Saving 24.2 23.5 23.4 26.1 28.1 Household Physical Saving 10.3 11.3 11.4 13.0 13.0 (Base 1999-2000) Item 1999-2000 2000-01 2001-02 2002-03 2003-04 Private final consumption exp. 64.2 63.7 64.4 63.2 61.7 Government final consumption exp 12.9 12.6 12.4 11.9 11.3 Gross Domestic Capital Formation 25.9 24.3 22.8 25.2 27.5 Valuables 0.8 0.7 0.6 0.6 0.9 Errors and Omissions -0.2 0.2 -1.3 0.0 0.8 Net Exports -1.9 -0.9 -0.9 -1.0 -1.3 Statistical discrepancies -1.3 0.4 0.0 0.7 1.6 GDP market prices 100.0 100.0 100.0 100.0 100.0 Gross Domestic Savings 24.8 23.7 23.5 26.3 29.8 Household Physical Savings 10.5 11.4 11.3 12.6 12.7 Source: National Accounts Statistics (NAS), 2005 and 2009 At the time of revision in the base year of national accounts (from 1993-94 to 1 9992000 in 2006), the CSO had also implemented various recommendations of UNSNA 199 3 including the treatment of valuables separately as a part of capital formation. Th is practice of enlisting valuables along with gross fixed capital formation and change in stoc k in the

gross capital formation has raised some issues over the sanctity of this treatme nt as well as its impact on the gross domestic capital formation (investment). Before we turn to these issues, an attempt is made to examine the data released by the CSO in this regard. With the objective of assessing the impact of incorporation of valuables 9 on the data on disposition of national income, a comparison of the data as per t he old and new series (Table 4) has been attempted below. On a perusal of the Table 4, a few observations can be made as follows: Valuables as a per cent of GDP at current market prices has moved in a narrow range of 0.6 to 0.9 per cent during the period 1999-2000 to 2003-04. In the rece nt years, the valuables account for around 1.3 per cent. This is significant, being close to the saving-investment balance of India during the normal years. Subsequent to the incorporation of valuables as capital formation, the GDCF estimates have undergone upward revision while the household physical saving estimates have undergone downward revision. At the same time, the estimates for private final consumption expenditure have undergone downward revision. The net result of the above factors is seen in terms of a decline in the level o f errors and omissions in the capital formation as also a decline in the quantum of statistical discrepancy in the national accounts. It may be mentioned that these two are summary measures of the efficiency of the compilation of the national accounts data. As regards the impact of inclusion of valuables in capital formation on private final consumption expenditure (PFCE), the reason could be that (to quote) the estimated purchases of jewellery and ornaments by the households reported in the NSS 55th Round survey on consumer expenditure has been treated as valuables and the same has not been accounted under PFCE in the new . (see Sources and method of national accounts statistics,2007 released by CSO). Section V Valuables - Some Measurement Issues Treatment of non-monetary gold The treatment of non-monetary gold has raised debate over the measurement of unallocated gold in the national accounts. Some of the countries under the aegis of UNSNA which did not support the recommendations of Advisory expert group (AEG) have be en listed in the Annex 1. The underlying concern in this debate has been to address the perceived distortion of physical trade statistics due to the inclusion of all bullion mark et transactions undertaken between resident and non-resident counterparties. In other words, the inclusion of all gold transactions between residents and non-residents as imports and exports of goods would seriously distort the economic accounts of those countries with large inte rnational markets in gold such as Japan and the United Kingdom. As a solution to this problem, there was a proposal for the creation of a new fi nancial instrument classification Financial Gold similar in nature to the current UNSNA concept 10 of Monetary Gold but broader in its scope (Chris Wright and Stuart Brown: 2006). Under this, the physical gold would then be classified as:

Commodity Gold if it is held for industrial use or as a valuable ; Non Monetary Financial Gold, if held by financial institutions and/or bullion traders for market making purposes; and Monetary Gold (a subset of Financial Gold) if held by Central Banks as a reserve asset. This proposal is nevertheless principally conceptual. A shared characteristic of financial instruments within the UNSNA framework is that they are issued by an i nstitutional unit and so represent a liability to that unit as well as an asset to the holder . Nevertheless, the global market in which gold is traded is highly sophisticated, exhibiting all of the characteristics of a financial market. This issue has been nicely dealt with in the revised version of UNSNA 2008. Once India adopts the UNSNA 2008, this issue would be req uired to be addressed in the Indian national account statistics. Sanctity of placing valuables in gross capital formation (investment) Capital formation may be defined as generation of goods that are used for at lea st a year in the process of production of other goods and services. It may be noted t hat dwellings are treated as fixed assets which is used, together with other inputs, to produc e housing services for renting or own use. Owner occupiers do not consume the dwellings as such but rather the housing services produced by the dwellings. Thus, the valuables which have only store of value do not correspond to capital formation in the economy. In India, people hold jewellery for fashion, security against unforeseen eventuality, etc. Therefore, the behavioral aspect of keeping jewellery for both consumption and investment motives may sugg est that valuables be kept out of the purview of capital formation in the national accounts statistics. The UNSNA systematically excludes acquisitions less disposals of valuables from the composition of gross fixed assets formation and locates the category after ch anges in inventories in the capital account. There are a number of other items in the capi tal account which do not form part of gross capital formation. It has been explicitly recogn ized that such net acquisitions of valuables do not contribute to production nor any imputed earn ing or rentals for such assets. Revision of ratios for measuring valuables As per Sources and Methods of National Accounts Statistics , in the new series (bas e 1999-2000) the coverage of valuables has been restricted to include the precious articles with HS codes 7102 (diamonds), 7103 (other gems and stones), 7106 (silver), 7108 (gol d), 7110 (platinum), 7113 and 7114 (gold and silver ornaments), keeping in view the data availability. The monetary gold was not regarded as valuables . The total production of valuables and net imports has been taken into account for compiling the estimates of valuables. 11 Since these valuables also have industrial use, norms of 95 per cent and 10 per

cent, respectively for gold and silver, have been used, to arrive at the estimates on acquisition of these items as a store of value. Suitable adjustments have been made on the expo rt data on valuables to account for value addition done in the country (GVA and change in s tock), so that imports and exports on valuables are on a comparative quantity terms. In th is regard, the CSO does not provide the reason for using these ratios to measure the non-indust rial use of gold and silver. Valuables and its implication for savings If the valuables are included as part of GCF, there ought to be a counterpart in savings to finance such investment. However, household saving in India is not di rectly estimated as the difference between household income and consumption; it is done indirectly with the estimates of saving in the form of financial and physical assets withou t taking into account valuables . Hence, net acquisition of valuables gets completely ignored in th e CSO s saving estimation procedure. Finally, this contradicts the UNSNA 1993 where valuables ought not to be treated as part of consumption. To be consistent, an equ ivalent amount of valuables has to be added to the domestic savings. Overall, both concept ually and from the point of view of its operational significance, it may not be approp riate to include acquisitions of valuables as part of GCF (EPW: 2006). More recently, the High Leve l Committee on Saving and Investment also discussed the issue. The report stated t hat the valuables were not treated either as intermediate consumption or as final consum ption expenditure for the measurement of consumption expenditure in the economy. Thus, it should be treated as a part of gross capital formation but separately from the gross fi xed capital formation and change in stock. Section VI Alternative Treatment- A Possible Way out The present treatment of non-monetary gold as valuables may have somewhat inflated the estimates of gross capital formation in the national accounts in In dia. Internationally, experts have proposed to reintroduce the UNSNA68 concept of fin ancial gold, but to restrict it to holdings by and transactions between financial insti tutions. Physical gold (investment grade only) held by financial institutions plus assets and liab ilities denominated in gold would all be considered as financial assets. Thus the curren t category of monetary gold would then become a subset of financial gold. Financial gold would be an asset without a corresponding liability in the overall UNSNA sector accounts, as is with monetary gold at present. Hence, other sectors of the domestic economy would onl y hold commodity gold as a valuable or for intermediate consumption as at present. When a

financial institution sells gold to a non-financial institution, the gold would be demonetised to a valuable first and the subsequent transaction would be a transaction in commodit y gold. If 12 one end of this transaction involves a non-resident then it would be recorded as imports or exports of commodity gold. Similarly, monetisation of gold would occur after the purchase of commodity gold by a financial institution from a non-financial institution (e.g. from a mining company or refiner). Financial derivatives and bank deposits/loans denominated i n gold would however continue to be financial assets for all sectors of the economy as in the current international standards. To sum up, the treatment of valuables may be looked at from the perspective of r ecent debate over the treatment of gold as a financial instrument. Furthermore, India is one of the largest importers and user of gold items for jewellery and other uses. Thus, the treatment of valuables as a part of gross capital formation is conceptually debatable when it has a significant share in GDP without resulting into capital formation activity. Henc e, for policy purpose, the valuables need not form part of capital formation in the economy as t here is no corresponding rise in capital formation as such which would be useful for genera ting economic growth. ***** 13 Select references: 1. Balakrishnan Pulapre and Suresh Babu (2007), Trends and Savings, Investment an d Consumption , Economic and Political Weekly, May 5, 2007. 2. Brent R. Moulton (2003), The System of National Accounts for the New economy: What Should Change?: Bureau of Economic Analysis U.S. Department of Commerce 1441 "L" Street, NW Washington, DC 20230, USA. 3. Chris Wright and Stuart Brown (2006), Non-Monetary Gold , fourth meeting of the Advisory Expert Group on National Accounts 30 January 8 February 2006, Frankfurt 4. The Report of the High Level Committee on Saving and Investment (Dr. C. Rangarajan), MOSPI. 5. Higher Investment by Statistical Revision (2006), Editorial of Economic and Political Weekly. 6. IMF (2007), The System of Macroeconomic Accounts Statistics: An Overview . IMF Pamphlet Series. 7. S. Venkitaramanan (2007), CSO's data estimates in the economy New light on savings and consumption , The Hindu Business Line, May 28, 2007 8. Sources and Method of National Accounts Statistics, CSO 2007. 9. Stephen Harmston (1998), Gold as a Store of Value . Research Study No 22. World Gold Council 10. United National System of Nation Accounts Various Issues (1968, 1993 and 200 8). http://unstats.un.org/unsd/nationalaccount. 11. World Gold Council (2010), India: Heart of Gold . World Gold Council 10, Old Bailey, London. 14

Annex 1: Country comments: Non-Monetary Gold classification Date posted Source Comment 2006-0915 United Kingdom The UK generally supports the proposals for the financial instrument classification as recommended by the AEG. We nevertheless have the following specific comments: In the associated discussion of gold at the 4th AEG meeting, we agree with the AEG's recommendations on the five questions posed under this heading but consider that the account of this topic in the meeting report indicates the need for particular care when relevant SNA text is being drafted. Specifically, the short report of the meeting says: "Again it is raised whether nonmonetary gold should be classified as a financial asset rather than under valuables in the asset classification. Non-monetary gold being a financial asset would allow for the gold transactions to be netted, in line with financial transactions." We consider this account to be misleading. The proposals in the agenda paper and the recommendations of the AEG do not affect either the classification of non monetary gold or its accounting treatment. The issue is rather to clarify that holdings of unallocated gold are financial assets (deposits) within the system rather than monetary or non monetary gold. This clarification will ensure that the bulk of bullion market dealing - which occurs using unallocated metal accounts - is recorded in the financial account while still leaving holdings of non monetary gold in the system to be recorded as valuables and reported gross in the relevant flow accounts. Holdings of allocated gold constitute title to physical metal and may be classified as monetary or non monetary gold depending on the classification of the institution holding title. Unallocated gold by contrast is an unsecured claim against a third party to deliver physical gold. In form it is directly comparable to an unsecured claim against a third party to deliver currency - a deposit in the language of the SNA. 2006-0818 Bank of England Nonmonetary gold: We agree with the AEG s recommendations on the five questions posed under this heading but consider that the account of this topic in the meeting report indicates the need for particular care when relevant SNA text is being drafted. Specifically, the short report of the meeting says: Again it is raised whether non-monetary gold should be classified as a financial asset rather than under valuables in the asset classification. Non-monetary gold being a financial asset would allow for the gold transactions to be netted, in line with financial transactions. We consider this account to be misleading. The proposals in the agenda paper and the recommendations of the AEG do not affect either the classification of non monetary gold or its accounting treatment. The issue is rather to clarify that holdings of unallocated gold are financial assets (deposits) within the system rather than monetary or non monetary gold. This clarification will ensure that the bulk of bullion market dealing is recorded in the financial account while still leaving holdings of non monetary gold in the system to be recorded as valuables and reported gross in the relevant flow accounts. 15 Holdings of allocated gold constitute title to physical metal and may be classified as monetary or non monetary gold depending on the classification of the institution holding title. Unallocated gold by contrast is an unsecured

claim against a third party to deliver physical gold. In form it is directly comparable to an unsecured claim against a third party to deliver currency a deposit in the language of the SNA. The meeting report goes on: Moreover, as a consequence, fee payments to owners of gold loans would be classified as property income rather than a service. This is again misleading. Gold lending normally (perhaps always) involves the transfer of physical metal allocated gold so that the nature of such transactions are more complex than implied here. While there may be a case for assigning associated payments as property income as indicated, the treatment of these specialised transactions warrants separate attention along with repurchase agreements and securities lending. 2006-0801 Hong Kong, China Nonmonetary gold: Given the specific nature of unallocated gold account, we agree to the AEG s recommendation that unallocated gold and metal accounts should be classified as financial assets/liabilities, whereas allocated gold and metal accounts, held outside the central bank, should continue to be regarded as ownership of nonfina ncial assets. This could avoid the distortion to external trade statistics when transactions related to unallocated accounts are significant. However, further study on whether transactions of allocated and unallocated gold can be easily identified in practice should be made before the decision made. It would also be useful to provide more examples to illustrate how the recommendation would affect GDP and various national accounts. 2006-0731 Bank of Indonesia (BI) Nonmonetary gold: BI questioning whether non monetary gold, gold coins and commemorative coins should be classified as financial assets? Currently BI still classify thos e assets as part of valuable in non-financial assets category. BI also agree with the proposed classification of more detail non-financial assets. 2006-0725 National Bank of Bahrain Nonmonetary gold: Although classifying unallocated gold accounts as financial assets/liabilities i s justifiable, we should be careful with classifying other metals or commodities as financial assets/liabilities, as these metals or commodities most likely do not have the characteristic of gold with the exception of some other precious metals. The treatment of non-monetary gold in the SNA must be consistent with its treatment in the BOP manual. As far as I know a paper discussing non-monetary gold has been issued by the BOPCOM. 2005-0506 Vietnam Nonmonetary gold: We agree with the recommendations that nonmonetary gold should be classified as a financial asset rather than under valuables in the asset classification. Non monetary gold transaction to be netted in financial transactions and free payments to owners under gold loans would be classified

as property income rather than a service. Source: United National System of National Accounts, https://WWW.unstats.un.org/ unsd/sna1993 16 Annex 2: SNA FRAMEWORK Production account GDP Income accounts Saving Capital account (nonfinancial assets) Opening Other Closing balance Net lending/borrowing economic balance sheet flows sheet Financial account (financial assets/ liabilities) 17